|
|
STOCK MARKET SHAKEDOWN
Securities lawsuits rough up
California businesses, big and small.
In April 2003, in Small v. Fritz Companies, Inc., the California Supreme
Court ruled that a shareholder who neither bought nor sold stock, but who merely
held on to shares he already owned, could sue a company if its public statements
turned out to be false or misleading.[88] The leap in legal
reasoning—one that federal courts have consistently rejected—sent tremors through
California's embattled corporate defense bar, which is now bracing for a wave
of lawsuits by investors claiming they relied on a company's faulty disclosure
to . . . well, do nothing.[89]
But for Trial Lawyers, Inc., which has made California the focal point of its
securities-litigation business, the supreme court decision was only the latest
victory in a long-running and largely successful campaign to wring money out
of the Golden State's embattled corporations. Of the 570 securities class actions
filed in federal district courts from 2001 through 2003, a whopping 23 percent
were filed in California.[90] The U.S. Court of Appeals
for the Ninth Circuit, which includes California, has far outpaced other federal
circuits in both filings and settlements (see graphs below).[91]
Indeed, the securities-litigation division of Trial Lawyers, Inc. has California's
high-growth, high-technology industrial base in its sights. Hightech companies'
shares and revenues are inherently volatile, and whenever these businesses must
restate their finances or suffer a drop in stock price, they become prime targets
of the plaintiffs' bar. Emboldened by public outrage at the malfeasance uncovered
at companies like Enron and WorldCom, trial lawyers have sued not only major
corporations such as Cisco Systems, but virtually every tiny technology company
that went public during the 1990s Internet boom.[92] Between
1997 and 2004, 43 percent of the securities lawsuits brought in federal district
court in the country were against technology companies.[93]
The list of defendants reads like a who's who of Silicon Valley: Oracle, Silicon
Graphics, Nortel Networks and on and on.[94]
Now, having worked their way through most of California's high-tech sector
and facing a diminishing number of targets, trial lawyers are turning their
attention to the state's burgeoning biotech industry. Nationally, suits against
biotech companies tripled between 2001 and 2003.[95] In
San Francisco alone, five companies are already in the crosshairs of the plaintiffs'
bar: Gilead Sciences, VaxGen, CV Therapeutics, Cerus, and Intermune.[96]
Trial Lawyers, Inc.'s "Pit Bull"
Leading the charge to the courthouse in most of those cases is none other than
San Diego pit bull Bill Lerach, who recently broke with plaintiff powerhouse
Milberg Weiss Bershad Hynes and Lerach, and formed his own firm, Lerach Coughlin
Stoia Geller Rudman and Robbins. With Lerach running their securities practices,
these firms were lead or co-lead plaintiff in 51 percent of class action securities
lawsuits brought in the U.S. between 1997 and 2004.[97]
During that time, he extracted $6 billion in settlements from corporations and
pocketed an estimated $2 billion for the firms.[98]
Between 1996 and 2003, 50 percent
of the securities lawsuits brought in
federal district court in California were
against technology companies. |
Federal legislation enacted in 1995 to rein in Mr. Lerach and his ilk—the Private
Securities Litigation Reform Act (PSLRA)[99]—required more
in-depth pleading standards to support a securities claim and forced judges
to select as the lead plaintiff in such cases the investor most likely to protect
the class of claimants' interests, typically the largest investor, rather than
merely permitting the first plaintiff filing suit to control the litigation.[100]
These changes put a stop to some of the most egregious abuses, including "strike
suits"—claims filed within days or even hours of a drop in stock price even
when little, if any, evidence of corporate wrongdoing existed.[101]
But an unintended consequence of the legislation was to stifle competition
and concentrate power in a few big plaintiff firms that have the capital to
spend time digging for the evidence now required by more rigorous federal pleading
standards.[102] The PSLRA also forced more marginal cases,
such as Small v. Fritz, into state court, where pleading standards are
more lenient.
In addition, the law's stipulation that the shareholder with
the biggest stake be the lead plaintiff had the effect of raising the ante for
Mr. Lerach and his colleagues in the plaintiffs' bar. Now, instead of having
to trawl for small investors, Trial Lawyers, Inc. spends its time wooing public
pension funds, whose boards of political appointees and labor representatives
make them natural allies in the battle to wrest money from corporate America
(see "Pension Politics").
The Cost of Shareholder Suits
With the political establishment stacked against them and the exorbitant cost
of defending years-long court battles, no wonder that 80 percent of securities class action cases are settled,
with only 1 percent of the companies willing
to take their cases to trial.[103] Indeed, critics liken
securities litigation to "legal extortion," and one judge has gone so far as
to compare lawyers at Lerach's old firm to " 'squeegee boys' who . . . run up
to a stopped car, splash soapy water on its perfectly clean windshield and expect
payment for the uninvited service of wiping it off."[104]
Although the plaintiffs' bar disingenuously claims its mission is to reform
management and protect the rights of the "little guy," empirical evidence shows
that securities class actions' settlement values are unrelated to the merits
of the underlying cases,[105] and the money to pay settlements
comes directly from the corporate coffers of the company in which small shareholders
have invested.[106] Securities claims are thus often nothing
more than a mechanism for transferring assets from one group of shareholders
to another, with a 30 percent cut for Trial Lawyers, Inc.
Furthermore, even for businesses that have yet to be sued, California's
extreme threat of litigation is helping to send accounting and insurance costs
through the roof and is causing entrepreneurs to question the wisdom of going
public.[107] James Currier, founder and CEO of San Francisco
– based Tickle, Inc., canceled a round of funding last year that was intended
to precede an initial public offering. Instead, he sold his company to Monster.com
when he realized the high cost of going public.[108] As
more company directors are implicated in shareholder suits, liability risks
also are causing venture capitalists to take a second look at their traditional
close involvement with the companies they bankroll. Vinod Khosla of Silicon
Valley venture firm Kleiner Perkins Caufield and Byers this year resigned his
seat on the board of Juniper Networks in part because new regulations have made
board members liable for company reports. "It's taking a risk," he told the
San Jose Mercury News.[109]
<<previous section | next section>>
88. 65 P.3d 1255 (Cal. 2003).
89. See, e.g., Gretchen Morgenson, Some Recourse for Those Who Believed
and Didn't Sell, N.Y. TIMES, May 11, 2003, at 31. For a federal decision refusing
to permit shareholders to sue in a securities suit without a purchase or sale
of stock, based on a common law fraud claim, see Chanoff v. U.S. Surgical Corp,
857 F. Supp. 1011, 1018 (D. Conn.), aff’d, 31 F.3d 66 (2d Cir.), cert.
denied, 513 U.S. 1058 (1994).
90. PRICEWATERHOUSECOOPERS, 2003 PRICEWATERHOUSECOOPERS
SECURITIES LITIGATION STUDY 7 (2004).
91. See id.; LAURA E. SIMMONS & ELLEN M. RYAN, CORNERSTONE RESEARCH, POST-REFORM
ACT SECURITIES SETTLEMENTS, UPDATED THROUGH DECEMBER 2004 16 (2005).
92. Bernadette Tansey, Rise in Biotech Lawsuits Industry Blames Law Firms Looking
for New Targets, S.F. CHRON., Jan. 26, 2004, at E1; Edward Iwata, Bruised
Cisco Faces Crucial Juncture on Road to Recovery, USA TODAY, Dec. 31, 2001,
at B1.
93. Simmons & Ryan, supra note 91, at 15.
94. See Nursing Home Pension Fund, Local 144 v. Oracle Corp., 380 F.3d
1226 (9th Cir. 2004); Brody v. Silicon Graphics Inc., No. C-96-0393-FMS (N.D.
Cal. .led Jan. 29, 1996); Weinstein v. Nortel Networks Corp., No. 1:01-cv-01855-RMB-MHD
(S.D.N.Y. filed Mar. 2, 2001).
95. Tansey, supra note 92, at E1 (reporting that PricewaterhouseCoopers
reported that three times as many biotech firms were sued in 2003 as in 2001).
96. See In re Gilead Sciences Secs. Litig., No. C03-4999 MJJ, 2005 WL 181885
(N.D. Cal. Jan. 26, 2005); Whitkens v. Vaxgen, Inc., No. 3:03-cv-01129 (N.D. Cal.
filed Mar. 17, 2003); In re CV Therapeutics, Inc. Secs., 59 Fed.R.Serv.3d
251, 2004 WL 1753251 (N.D. Cal. 2004); Laf.n v. Cerus Corp., No. C 03-5517-JF
RS., 2004 WL 3080344 (N.D. Cal. Mar. 22, 2004); In re Intermune, Inc. Secs.
Litig., No. C 03-2954 SI., 2004 WL 1737264 (N.D. Cal. July 30, 2004).
97. Simmons & Ryan, supra note 91, at 14.
98. Robert Lenzner & Emily Lambert, Mr. Class Action, FORBES, Feb. 16,
2004, at 8; Neil Weinberg & Daniel Fisher, The Class Action Industrial Complex,
FORBES, Sept. 20, 2004, at 150.
99. Pub. L. No. 104-67, 109 Stat. 737 (1995) (codi.ed as amended in scattered sections of 15
& 18 U.S.C.A.).
100. Id. at § 21D(b); § 21D(a)(3)(B)(i).
101. See James A. Kassis, The Private Securities Litigation Reform Act of 1995:
A Review of Its Key Provisions and an Assessment of Its Effects at the End of
2001, 26 SETON HALL LEGIS. J. 119, 122-24 (2001).
102. See Tamara Loomis, In Spite of Reform Law, Milberg Weiss Emerges as Winner
in Securities Suits, 229 N.Y.L.J., Apr. 22, 2003, at 1.
103. Tansey, supra note 92, at E1 (citing a report by NERA Economic Consulting).
104. See id. at E1 ("Silicon Valley executives accused the [Milberg Weiss
Bershad Hynes and Lerach] firm of what they called 'legal extortion.' Dozens
of companies settled shareholders suits, if only to avoid the expense of defending
them."); Judge Compares Milberg Weiss Case to the Squeegee Man, NEW YORK
LAW., Apr. 18, 2002, available at http://www.nylawyer.com/news/02/04/041802e.html
(last visited Mar. 5, 2005).
105. See Janet Cooper Alexander, Do the Merits Matter? A Study of Settlements
in Securities Class Actions, 43 STAN. L. REV. 497 (1991) (concluding that
the settlement value in securities fraud cases is not function of merit).
106. In a typical securities case, shareholders who bought or sold shares within the
time period of the alleged fraud receive compensation from the company. Other
shareholders, as owners of the company, by definition pay the money out to the
claimants. Small investors who passively hold diversified portfolios of investments
inevitably lose from such suits, given their transaction costs, if the suits do
not actually deter misconduct.
107. See John Shinal, Going Public Getting Harder as IPOs Become Costlier,
Some CEOs Decide to Sell, S.F. CHRON., Aug. 30, 2004, at C1 (reporting that
accounting costs and liability insurance have increased "signi.cantly").
108. See id. (reporting on Mr. Currier's decision not to take Tickle, Inc.
public and stating that "[a] growing number of entrepreneurs, faced with spiraling
accounting costs and stiffer corporate governance rules, are choosing to keep
their startups private or sell them to a rival rather than take them public").
109. Matt Marshall, VC Leaves Juniper Board, Blames New Rules, (San Jose,
Cal.) MERCURY NEWS, Apr. 12, 2004, at 1C. 23.
|
|
